Echostar recently announced it will invest $50 million to increase its interest in Starband to 32 percent. Starband is a Ku-band two-way high-speed Internet access service that is targeting the consumer and SOHO (small office/home office) markets that was formed in 1999 by VSAT industry leader, Gilat Satellite Networks, and counts Echostar and Microsoft among its strategic investors. For the past year, however, Starband has been between a rock and a hard place, shut out of the capital markets and unable to tap its strategic partners for the additional funds necessary to launch new satellites.

Echostar also has committed to launch a new spotbeam satellite for Starband based on Starband’s proposed Ku-/Ka-band spotbeam design specifications that should reduce its bandwidth cost structure versus current technology. Gilat will provide Echostar with proprietary technology and the engineering expertise to help construct and operate the satellite. Echostar’s interest in Starband will increase to 60 percent once construction of this satellite begins, which Gilat expects will commence by the end of this year.

The bottom line is we believe this is a positive agreement for all parties involved. For one, we believe Echostar is acquiring a valuable asset at a very attractive price. As recently as last year, Starband had planned to IPO roughly a third of the company for over $1 billion. At the same time, Starband benefits from Echostar’s strong distribution, satellite operating expertise, and attractive product DBS/broadband bundling opportunities, which we believe will be necessary to compete effectively with Hughes’ DirecWay and terrestrial alternatives.

While Gilat’s interest in Starband will be diluted because of this transaction, we believe this is already priced into shares of GILTF. Given Gilat’s current difficulties with its core business and probable inability to further fund Starband, Echostar’s investment does much more than enhance the competitiveness of Starband’s offering. It ensures Starband’s viability as on ongoing entity and removes the potential risk that Gilat loses what it has already invested in Starband.

Moreover, a successful Starband should provide a significant source of revenue for Gilat, as it is the manufacturer of Starband consumer equipment. Starband is in the process of rolling out Gilat’s new Starband Model 360 satellite modem, which is a derivative of the company’s Starblaster VSAT modem. Gilat should be able to achieve significant economies of scale in the manufacturing process by using the same terminal architecture for both services.

Dish Network retailers have already begun selling the Starband service with the Model 360 modem, which is based on its Starblaster VSAT modem. We look for Echostar to focus principally on selling the Starband service as part of a bundled Dish Network/Starband offering, employing a leased equipment sales model with a monthly rental and service fee that is a slight premium to cable offerings. Consumer acceptance of Starband should be strongest among Echostar’s rural customers who do not have access to a competing DSL or cable alternative.

Echostar’s alignment with Gilat/Starband is setting the stage for two national broadband satellite services: Dish/Starband and DirecTV/DirecWay. The potential market for broadband satellite services in North America is large enough to support at least two players, as with the DBS business. We estimate this market to be the 20 to 30 million U.S. households that are not likely to have access to a DSL or digital cable service in the near future.

The question then becomes what is in store for next-generation Ka-band systems under development? Hughes has indicated that it remains committed to completing the North America segment of its Spaceway system, in which it has already invested $1.4 billion. We expect Hughes will target DirecTV subscribers with its Ku-band DirecWay offering, while positioning Spaceway more toward the SOHO/enterprise markets, transitioning some of its VSAT customers with more sophisticated networking needs to Spaceway terminals.

It is less clear what lies in-store for Wildblue, a second planned Ka-band service, whose investors include Echostar and News Corp. If Murdoch acquires Hughes, and by extension Spaceway, he may not need Wildblue. Alos, it does not appear that Echostar will expand this partnership with Wildblue at this time. Echostar’s CEO Charlie Ergen basically confirmed this during the company’s 2Q01 conference call, with his comments that Ka-band was still further down the evolutionary road and that Ku-band offers a better risk-return profile given its proven technology and easy compatibility with DBS.

Then there is Astrolink, a Lockheed Martin led global Ka-band system, whose investors include Liberty Media, which is closely aligned with News Corp. as the largest holder of News Corp. stock, other than the Murdoch family. If Murdoch acquires Hughes, we expect some rationalization of Astrolink and Spaceway, such as keeping Spaceway over North America and employing Astrolink over other global regions. It is unclear to us at this point how compatible the two systems are, although our initial read is that it would be easier to combine Spaceway and Astrolink with one another, than to combine either with Wildblue. Nevertheless, it is somewhat ironic that if a global broadband satellite service provider emerges any time soon, it could be a combination of several ventures initially proposed as standalone systems. Who says the capital markets are not rational?

Armand Musey is the satellite communications analyst at Salomon Smith Barney (“SSB”). The foregoing article should not be considered as a recommendation with respect to any security. SSB and its affiliates may maintain a long or short position in, act as a market maker for, or purchase or sell a position in, securities of referenced entities and may also perform investment banking, advisory, or other services for any such entity.